Depreciation vs Amortization

What Is Depreciation?

Depreciation is the systematic allocation of the cost of a tangible asset over its useful life. Tangible assets are physical items that you can see and touch: buildings, machinery, vehicles, computers, and furniture. As these assets are used in business operations, they gradually wear out, lose efficiency, or become technologically obsolete. Depreciation captures that decline in value as an annual expense.

For accounting purposes, depreciation matches the cost of an asset to the revenue it helps generate over multiple periods. For tax purposes, it provides an annual deduction that reduces taxable income.

What Is Amortization?

Amortization is the systematic allocation of the cost of an intangible asset over its useful life. Intangible assets lack physical substance but still provide value: patents, copyrights, trademarks, franchise agreements, goodwill, and certain types of software. Like depreciation, amortization spreads the cost over the periods that benefit from the asset.

Note that "amortization" is also used in the context of loan repayment schedules. In this guide, we focus exclusively on the amortization of intangible assets for accounting and tax purposes.

When Does Each Apply?

The distinction is straightforward: if the asset is physical and has a finite useful life, it is depreciated. If the asset is non-physical and has a determinable useful life, it is amortized.

• Depreciation: Buildings, vehicles, machinery, equipment, furniture, leasehold improvements.
• Amortization: Patents, copyrights, trademarks, goodwill, franchise rights, licensing agreements, customer lists.
• Neither: Land (infinite life), inventory (expensed when sold), financial instruments (different accounting rules).

Key Differences at a Glance

Depreciation Methods

Multiple methods exist for depreciating tangible assets. The choice depends on the type of asset, jurisdiction, and whether you are reporting for financial statements or tax returns.

Straight-Line (SL)

The simplest method. Cost minus salvage value is divided evenly over the useful life. Each year receives the same deduction.

Annual Depreciation = (Cost - Salvage Value) ÷ Useful Life

Declining Balance (DB)

Applies a fixed percentage rate to the remaining book value each year. Produces higher deductions in early years and lower deductions later. Common rates are 150% or 200% of the straight-line rate.

Double Declining Balance (DDB)

A specific form of declining balance using twice the straight-line rate (200%). The asset is often switched to straight-line in later years to ensure it is fully depreciated by the end of its useful life.

Annual Depreciation = 2 × (1 ÷ Useful Life) × Book Value

MACRS (Modified Accelerated Cost Recovery System)

The standard tax depreciation system in the United States. MACRS assigns assets to property classes (3, 5, 7, 10, 15, 20, 27.5, or 39 years) and uses IRS-published percentage tables. Most personal property uses the 200% declining balance method switching to straight-line under the General Depreciation System (GDS).

Sum-of-the-Years-Digits (SYD)

An accelerated method where the depreciation rate decreases each year. The fraction is calculated by placing the remaining life over the sum of all years' digits.

Year N Depreciation = (Remaining Life ÷ Sum of Years' Digits) × (Cost - Salvage)

Units of Production (UOP)

Ties depreciation to actual usage rather than time. Ideal for assets where wear is driven by output, such as manufacturing equipment or vehicles.

Depreciation per Unit = (Cost - Salvage) ÷ Total Estimated Units

Amortization Methods

Straight-Line Amortization

Almost all intangible assets are amortized using the straight-line method. The cost is divided equally over the asset's useful life. There is typically no salvage value for intangible assets.

Annual Amortization = Cost ÷ Useful Life

Section 197 Intangibles

Under U.S. tax law, Section 197 intangible assets acquired as part of a business acquisition must be amortized over 15 years using the straight-line method, regardless of the asset's actual useful life. This includes:

• Goodwill and going concern value
• Workforce in place
• Patents, copyrights, and formulas
• Customer-based intangibles (customer lists, relationships)
• Licenses, permits, and franchise rights
• Trademarks and trade names
• Covenants not to compete

Tax Implications

Both depreciation and amortization reduce taxable income, but there are important differences in how they are treated for tax purposes.

Depreciation Tax Treatment

• MACRS is mandatory for most tangible business property in the US.
• Section 179 allows immediate expensing of qualifying assets up to an annual limit ($1,220,000 for 2024).
• Bonus depreciation (currently 40% for 2025, phasing down annually) allows additional first-year deductions.
• When a depreciated asset is sold for more than its book value, depreciation recapture may apply (taxed as ordinary income under Section 1245 or partially as capital gains under Section 1250).

Amortization Tax Treatment

• Section 197 intangibles must be amortized over exactly 15 years.
• No accelerated amortization or bonus deductions are available for Section 197 assets.
• Startup costs and organizational expenses can be partially deducted in the first year (up to $5,000 each) with the remainder amortized over 15 years.
• If a Section 197 intangible becomes worthless, you generally cannot claim a loss until all Section 197 intangibles from the same acquisition are disposed of.

Real-World Examples

Example 1: Depreciating a Delivery Truck

A logistics company purchases a delivery truck for $60,000 with an estimated salvage value of $5,000 and a useful life of 10 years.

Straight-line: ($60,000 - $5,000) ÷ 10 = $5,500 per year for 10 years.

MACRS (5-year property): Using GDS half-year convention tables, the truck would be depreciated over 6 tax years with deductions of $12,000 (Yr 1), $19,200 (Yr 2), $11,520 (Yr 3), $6,912 (Yr 4), $6,912 (Yr 5), and $3,456 (Yr 6). The total equals $60,000 with no salvage value under MACRS.

Example 2: Amortizing a Patent

A pharmaceutical company acquires a patent for $300,000 with 15 years of remaining legal life.

Straight-line amortization: $300,000 ÷ 15 = $20,000 per year for 15 years.

If the patent was acquired as part of a business purchase, it would be treated as a Section 197 intangible and amortized over exactly 15 years regardless of the remaining legal life. If acquired independently (outside of a business acquisition), it would be amortized over the remaining legal life.

Common Misconceptions

• "Depreciation means the asset is losing market value." Not necessarily. Depreciation is an accounting allocation of cost, not a measure of market value. A building may appreciate in market value while being depreciated on the books.
• "Amortization only applies to loans." While loan amortization is a common use of the term, in accounting it equally refers to the systematic expensing of intangible asset costs.
• "You can choose any method you want." For US tax purposes, MACRS is required for most tangible property, and Section 197 rules are mandatory for qualifying intangibles. Financial reporting may allow more flexibility under GAAP or IFRS.
• "Fully depreciated assets have no value." A fully depreciated asset simply has a book value of zero (or salvage value). It may still be in active use and have significant economic or resale value.
• "Land improvements are the same as land." Land itself is not depreciable, but land improvements (landscaping, parking lots, fencing) have a finite useful life and are depreciable, typically over 15 years under MACRS.
• "Goodwill lasts forever and shouldn't be amortized." Under US tax law, goodwill must be amortized over 15 years. Under GAAP, goodwill is not amortized but is tested annually for impairment. Under IFRS, goodwill is also tested for impairment rather than amortized.